What is Quantitative easing?


What is quantitative easing?

Quantitative easing is when a central bank like the Bank of England creates new money to stimulate the economy. They do this by increasing the supply of money to financial institutions (to lend to consumers) and businesses to invest in technology and innovation. An increased money supply amongst lenders helps reduce interest rates so consumer borrowing is cheaper. This in turn means consumers are now more likely to spend more on their credit cards and on loans as the cost of borrowing is much cheaper.

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How does quantitative easing work?

The Bank of England makes asset purchases from the private sector, for example from pension funds, high-street banks and non-financial firms. Most of these assets are government bonds (also known as gilts). The market for government bonds is large, so they can buy large quantities of them fairly quickly. The government bonds would have been previously sold to businesses and consumers by the government in order for the government to raise funds.⠀⠀⠀⠀⠀⠀⠀⠀⠀

The purchases are of such a scale that they push up the price of assets(due to an increased demand) and in turn lowering the yields (the return) on them. This encourages those selling these assets to use the money they received from the sale to buy assets with a higher yield instead, like company shares and bonds. This increases capital available to businesses etc and in turn boosts the economy as businesses now have more funds to hire more people who in turn will now have more money to pay in taxes and spend in shops. The companies now have more income and pay more corporation tax.⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀

As more of these other assets(company shares & bonds) are bought, their prices rise because of the increased demand. This pushes down on yields in general. The companies that have issued these bonds or shares benefit from cheaper borrowing because of these lower yields (caused when asset (bonds & shares) prices rise but interest rates remain the same) , encouraging them to spend and invest more. ⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀

The central Banks also buys a smaller amount of private debt like corporate bonds. This is aimed at making it easier for companies to raise money in capital markets to invest in their business. ⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀⠀
Those selling assets to the Central Bank have more money in their bank accounts as a result. Commercial banks for example can use these new funds to finance new loans, encouraging more spending.

The aim of quantitative easing is to increase the money supply in the economy and kickstart the economy towards increased spending and a much larger GDP growth.

What else can quantitative easing achieve?

If inflation looks like it is becoming too high, the Bank of England can then sell the assets they have purchased through quantitative easing to reduce the amount of money and spending in the economy. This works by increasing the supply of Bonds and shares on the market and this in turn reduces their prices and makes interest rates appear higher for those who save and more expensive for those who borrow to shop.

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